Chapter 4 Mechanics of Financial Information

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1 BUS210 Chapter 4 Mechanics of Financial Information

2 What do you remember?

3 Economic Events--> Transactions Reducing events to numbers

4 Connecting the Accounting Equation with Transactions: Journal Entries, T Accounts

6 E4-9 Prepare journal entries for each cash transaction during January, (assume beginning balance is $5,000). 1. Issued 600 shares of stock for $25 each. 2. Sold services for $4, Paid wages of $1, Purchased land as a long-term investment for $9, Paid a $2,000 dividend. 6. Sold land with a book value of $3,000 for $3, Paid $1,500 to the bank: $900 to reduce the principal on the outstanding loan and $600 as an interest payment. 8. Paid miscellaneous expenses of $1,800.

7 Show how the five transactions affect the accounting equation, express as journal entries, post to T accounts, and prepare financial statements. 1. Shareholders contributed $10,000 cash in the first year of operations. 2. Performed services for $8,000, receiving $6,000 cash and a $2,000 receivable. 3. Incurred expenses of $6,000. Paid $3,000 in cash, and $3,000 is still payable. 4. Purchased land for $12,000. Paid $2,000 in cash and signed a long-term note for the remainder. 5. Paid shareholders $400 in the form of a dividend. 6. Sold one-half of the land purchased in (4.) for $7,000 cash.

8 Balance Sheet- Beginning E4-4 Financial statement relationships Balance Sheet -Ending Cash Statement of Cash Flows Cash Other CA Cash-Operating Other CA LT Assets Cash-Investing LT Assets T Assets Cash-Financing T Assets? Change in Cash C Liab. Cash C Liab. LT Liab. Cash ? LT Liab. CC CC RE Income Statement RE T L+SHE Revenue T L+SHE? Expenses Net Income? Statement of Shareholders Equity Contributed Capital Retained Earnings Beginning NI Dividends Stock Issue XXXXXXXXXXXXXX XXXXXXXXXXXXXX XXXXXXXXXXXXXXXXX Ending??

9 Show how the eight transactions affect the accounting equation, prepare journal entries, and prepare an income statement, statement of shareholders equity, balance sheet, and statement of cash flows. 1. Collected $12,000 in cash from shareholders. 2. Borrowed $5,000 from a bank. 3. Purchased two parcels of land for a total of $10, Paid $5,000 to rent lawn equipment for the remainder of the year. 5. Provided lawn services, receiving $10,000 in cash and $4,000 in receivables. 6. Paid miscellaneous expenses of $4, Sold one parcel of land with a cost of $3,000 for $2, Paid a $2,200 dividend to the shareholders.

10 E4-10a Financial statement relationships Balance Sheet- Beginning Balance Sheet -Ending Cash Statement of Cash Flows Cash Other CA Cash-Operating Other CA LT Assets Cash-Investing LT Assets T Assets Cash-Financing T Assets? Change in Cash C Liab. Cash C Liab. LT Liab. Cash ? LT Liab. CC CC RE Income Statement RE T L+SHE Revenue T L+SHE? Expenses Net Income? Statement of Shareholders Equity Contributed Capital Retained Earnings Beginning NI Dividends Stock Issue XXXXXXXXXXXXXX XXXXXXXXXXXXXX XXXXXXXXXXXXXXXXX Ending??

12 Balance Sheet- Beginning Financial statement relationships Balance Sheet -Ending Cash Statement of Cash Flows Cash Other CA Cash-Operating Other CA LT Assets Cash-Investing LT Assets T Assets Cash-Financing T Assets? Change in Cash C Liab. Cash C Liab. LT Liab. Cash ? LT Liab. CC CC RE Income Statement RE T L+SHE Revenue T L+SHE? Expenses Net Income? Statement of Shareholders Equity Contributed Capital Retained Earnings Beginning NI Dividends Stock Issue XXXXXXXXXXXXXX XXXXXXXXXXXXXX XXXXXXXXXXXXXXXXX Ending??

13 What do you know? Preparing financial statements from simple transactions George began a business, and after collecting $6,000 from an equity investor and borrowing $5,000 from a bank, he purchased a piece of land for $8,000. During the year, he leased the land to Sheila and received $3,000 in cash. He paid $2,500 cash for expenses during the year and paid a $800 dividend to the equity investor. Prepare an income statement, statement of stockholders equity, a balance sheet, and a statement of cash flows for the period. What did George do that may have concerned the bank? Explain.

14 Balance Sheet Begin Financial statement relationships Balance Sheet End Cash Statement of Cash Flows End Cash Other CA Cash-Operating Other CA LT Assets Cash-Investing LT Assets T Assets Cash-Financing T Assets? Change in Cash? C Liab. Cash Begin? C Liab. LT Liab. Cash End? LT Liab. CC CC RE Income Statement (year ending ) RE T L+SHE Revenue T L+SHE? Expenses Net Income? Statement of Shareholders Equity (year ended ) Contributed Capital Retained Earnings Begin NI Dividends Stock Issue XXXXXXXXXXXXXXX XXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXX End??

16 Matching & Accrual Accounting Basic to financial reporting of corporations. Concerned with the timing of revenue and expense recognition. Purpose is to accurately measure revenues and expenses (and profits) for each accounting period. Accrual accounting s Income Statement attempts to match revenues earned and the expenses incurred, NOT cash flows. Accrual accounting s Statement of Cash Flows reports the cash inflows and outflows for the period.

17 Accrual Income Statement Reported revenues include: Revenues collected in a prior period deferred to the current period (reported previously on the balance sheet as a liability, Unearned Revenues) Revenues collected in the current period that were also earned currently. Revenues earned (and accrued) currently that will be collected in future periods (reported currently on the balance sheet as an asset, Accounts Receivable.

18 Accrual Income Statement Reported expenses include: The cost of goods or services consumed in the current period that were paid for in a prior period, but deferred to the current period (reported previously on the balance sheet as an asset; i.e., Inventories, Prepaid Expenses). The cost of goods or services consumed in the current period that were also paid for in the current period. The cost of goods or services consumed in the current period that will be paid for in future periods (reported on the current balance sheet as a liability; i.e., Accounts Payable).

19 Accrual Balance Sheet Assets on the Balance Sheet include: Something that has future or potential value. Future expenses for which cash has already been paid. (Prepaid i.e., deferred Expenses) Past revenues for which cash has not been collected. (Accounts Receivable i.e., accrued revenues) Liabilities on the Balance Sheet include: Responsibilities or promises to others Past expenses for which cash has not been paid. (Accrued Expenses Payable) Future revenues for which cash has already been collected. (Deferred or Unearned Revenues)

20 Accruals and Deferrals A deferral asset or liability is created on the balance sheet anytime cash is collected or paid BEFORE the associated expense or revenue is recognized (deferred). Examples: Inventories, Prepaid expenses, Equipment, Unearned revenues. An accrual asset or liability is created on the balance sheet any time revenue or expense is recognized (accrued) BEFORE the associated cash flow is received or paid. Examples: Accounts Receivable, Interest Receivable, Accounts Payable, Taxes Payable.[Expense now, Pay later. OR Receive later, Revenue now.]

21 Adjusting Entries: 4 Kinds

22 Adjusting Entries: 4 Kinds

23 E4-12 Adjusting journal entries Explain each of the entries and classify each of the entries as either a deferral (cost expiration) AJE or an accrual AJE. Rent Expense 1,200 Rent Payable 1,200 Insurance Expense 5,000 Prepaid Insurance 5,000 Depreciation Expense 20,000 Accumulated Depreciation 20,000 Interest Receivable 1,500 Interest Revenue 1,500 Unearned Revenue 200 Fees Earned 200

25 P4-8 Preparing adjusting journal entries a. The supplies balance is $85,000. A count of supplies reveals that the company actually has $30,000 of supplies on hand. Supplies Exp 55,000 Supplies 55,000 b. As of the company had not paid the rent for the month. The monthly rent is $2,400. Rent Exp 2,400 Rent Pay 2,400 c. On the company collected $18,000 in customer advances for the subsequent performance of a service. As of two-thirds of the service had been performed. Unearned Service Rev 12,000 Fees Earned 12,000 d. The total cost of fixed assets is $500,000. The company estimates that the assets have a useful life of ten years and used straight-line depreciation. DE 50,000 AD 50,000

26 P4-8 Preparing adjusting journal entries e. The company borrowed $10,000 at an annual interest rate of 12% on The first interest payment will be made Interest Exp 600 Interest Pay 600 f. The company placed several ads in newspapers during the month. On the company received a $28,000 bill for the ads, which was not recorded at the time. Adv Exp 28,000 Adv Pay 28,000 g. On the company paid the premium for a one-year life insurance policy. The $350 cost of the premium was capitalized when paid. Insurance Exp 175 Prepaid Insurance 175

29 P4-9 Inferring adjusting journal entries from changes in T-account balances Account Balance before AJE Prepaid rent 14,500 Prepaid insurance 8,500 Accum. Deprec. 36,000 Rent expense 6,500 Insurance expense 5,500 Depreciation expense 0 Balance after AJE 11,800 7,800 38,400 9,200 6,200 2,400

30 P4-9 Inferring adjusting journal entries from changes in T-account balances Account Balance before AJE Salaries payable 1,300 Unearned revenues 800 Fees earned 87,600 Salary expense 3,500 Balance after AJE 2, ,800 4,700

31 E4-21 Reverse T-account analysis 1. Compute the wages payable: Wages Cash payments during 2012 $35,000 Wages Payable as of $17,000 Wages Expense on the 2012 IS $39,000

32 E4-21 Reverse T-account analysis 2. the 2012 cash payments for rent: Rent Prepaid Rent $12,000 Prepaid Rent $15,000 Rent Expense on the 2012 IS $21,000

33 E4-21 Reverse T-account analysis 3. the accounts receivable as of : Accounts Receivable Cash collected from customers during 2012 $38,000 Accounts Receivable as of $14,000 Sales Revenue on the 2012 IS $45,000

34 P4-20 Reverse T-account analysis You are a credit analyst for a bank. Badger Business has applied for a loan. The company claims to have more than tripled profits from 2011 to 2012 and believes that it should be given prime credit terms. In addition, you note that Badger has expanded its operations, recently paying $37,000 for new equipment that replaced old equipment, which was sold that same year. No other transactions affected the company s equipment account. Excerpts from the 2012 financial statements are provided below. Balance sheet: Equipment $97,400 $84,800 Acc. Depreciation (26,400) (24,300) Income statement: Net income $5,200 $1,500 Depreciation expense $8,700 $7,600 Statement of cash flows: Proceeds from equipment sale $23,400 0

35 E4-16 The difference between cash and accrual accounting Washington Forest Products began operations on January 1, On December 31, 2011, the company accountant ascertains that the following amounts should be reported as expenses on the income statement: Insurance Expense $20,000; Supplies Expense $11,000; Rent Expense $14,000. A Review of the company s cash disbursements indicates the company made related cash payments during 2011 as follows: Insurance $29,000; Supplies $27,000; Rent $8,000 Explain why the amounts shown as expenses do not equal the cash paid. For each expense account, compute the amount that should be shown in the related balance sheet account as of December 31, 2011 (remember the company begin operations this year).

36 4 Closing Entries: Income Statement and Dividend Accounts

38 2 Closing Entries: Income Statement and Dividend Accounts

40 E4-7 Preparing financial statements Taken from the 2008 annual report of Bristol-Myers Squibb, a world-leading drug company (dollars in millions), reconstruct the financials. Cost of goods sold $ 6,396 Net cash from operations 3,707 Accounts receivable 3,710 Restructuring expense 218 Net cash from financing (2,582) Shareholders equity 12,241 Net cash from investing 5,079 Research & dev. expense 3,585 Other noncurrent assets 9,384 Other expenses 901 Marketable securities 289 Cash and equivalents $ 7,976 Short-term borrowings 154 Adv. & product expense 1,550 Accounts payable 1,535 Long-term liabilities 10,601 Net sales 20,597 Property, plant, & equip. 5,405 Other current assets 2,788 Other current liabilities 2,085 Sell. & adm. expenses 4,792 Accrued payables 2,936

BUS210. Chapter 4 Sessions 4, 5, 6, & 7 Mechanics of Financial Information

BUS210. Chapter 4 Sessions 4, 5, 6, & 7 Mechanics of Financial Information BUS210 Chapter 4 Sessions 4, 5, 6, & 7 Mechanics of Financial Information Connecting the Accounting Equation with Transactions: Journal Entries, T Accounts E4-9 Prepare journal entries for each cash transaction